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Will the Chicago Cubs’ Debt Prevent Any Big Free Agent Signings After This Season?

This weekend, before the Carlos Zambrano hullabaloo, the Chicago Cubs’ world was atwitter with concerns about the team’s financial health. After a review of publicly-available information about the financial state of the Cubs, I believe the concerns – both that the Cubs are in danger of going under and that payroll will have to be dramatically slashed after this season – are probably unfounded.

The genesis of the dismay came from a report that, together with eight other teams, the Cubs were operating in violation of Major League Baseball’s debt service rules. From the outset, I was confident that the report was a non-story (in fact, I was so confident that I relegated the report to a Bullets post – in the lowly third bullet position, no less!). MLB’s debt service rules – which discourage teams from operating at debt levels in excess of ten times their annual earnings – are designed to prevent teams from outspending their means, and heading into financial ruin, a la the Dodgers and Mets. The rules are not designed to impugn the financial integrity of a team whose recent sale was heavily debt-financed (not to mention heavily investigated – and approved of – by the Commissioner’s Office). But too few in the media gave the issue the critical thought it deserved, instead opting to raise a fear storm on the shakiest of grounds.

Sure enough, within hours, Commission Bud Selig confirmed that he had no concerns about the Cubs’ financial health.

But once folks were talking about the Cubs’ debt situation, the story snowballed, culminating in an article of legitimate interest by Gordon Wittenmyer, suggesting that the Cubs’ debt situation could negatively impact the team’s ability to “add any big free agents for two or three years.” Wittenmyer’s source claimed to have knowledge of “the annual burden” associated with “the Cubs’ purchase deal and debt structure,” knowledge that the public cannot duplicate.

But it got me wondering: using publicly-available financial information, how well could we corroborate or refute the assertion that the debt incurred by the Ricketts family in order to purchase the Cubs will preclude the Cubs from adding any “big” free agents in the immediate future? And should we actually be concerned about the Cubs’ financial health?

The intimate details of the Cubs’ financial dealings are private, but, each year, MLB and its teams permit Forbes to explore their books for the limited purpose of determining things like team value, team debt, team expenses and team revenues. Using those numbers for the 2010 season (and a few from the 2009 season), we can draw some similarly limited conclusions about the Cubs’ financial health and the team’s ability to keep its payroll sufficiently high as to add a big name or two this offseason.

A word of caution (and CYA): I am not an accountant. I’m simply a dude with a basic understanding of financials, a calculator, and some numbers. You take my word as gospel at your own peril.

Away we go.

Tom Ricketts has been widely quoted as saying that the family expects to put whatever dollars come in the door right back out into the organization, so it’s fair to say that the starting point for our discussion of the Cubs’ 2012 financial ability should be the team’s expected 2011 revenue. In 2010, the Cubs brought in about $258 million, which was an increase of $12 million over the previous year. This year, growth figures to flatten with attendance down upwards of 8%. We’ll be conservative, and estimate a 2011 revenue figure of $250 million.

To figure out how much room the Cubs should have for payroll in 2012 – again, assuming the Ricketts spend each dollar that comes in the door – we need to know two other expenses: (1) non-payroll expenses (Draft and international signing bonuses, organizational salaries and expenses, etc.), and (2) payment on the team’s debt.

In 2010, the Cubs’ non-payroll expenses totalled about $90 million ($258 million in revenue minus $144 in payroll expenses minus $23 million in operating income equals $90 million in non-payroll expenses). With modest inflation – 3% – that number figures to be around $93 million this year.

As for payment on the team’s debt, which Forbes puts at about $580 million, I’m making some educated guesses here. First, I’m considering only the required interest on the debt, and I’m doing so because (a) any payment to principle buys equity for the Ricketts (I don’t think its fair that Cubs’ revenue should be doing that; after all, the Ricketts bought the Cubs, not the other way around); and (b) by my math, the Ricketts paid down the principle by only about $1 million last year.

Second, I’m pegging the interest rate at the average between the prevailing rate for a jumbo mortgage (we’ll call it 5.25%) and the jumbo rate back in February 2009 (7.25%). That seems like a pretty reasonable guess at the interest rate on the Cubs’ healthy package of debt.

At 6.25%, the annual interest on the Cubs’ debt is about $36 million. Together with the estimated non-payroll obligations, the Cubs figure out pay out about $129 million this year before getting to the payroll.

Assuming the Cubs use the 2011 numbers to project their budget for 2012, subtracting $129 million from $250 million in revenues leaves $121 million for payroll in 2012. With salaries coming off the books such that the Cubs’ 2012 payroll obligations stand at just $72.6 million plus arbitration raises, there should be plenty of room there to add a couple “big name” free agents – and that’s assuming the Ricketts limited their expenditures to the Cubs’ revenue.

Now then.

This kind of back-of-the-napkin exercise is certainly an interesting discussion piece, but may provide limited utility for at least two reasons. First, as I suggested before, we don’t know the full numbers or the payments required under the Cubs’ purchase deal. We can spitball a bit, as I have, but the numbers could vary in significant ways.

Second – and this is a big one – whatever the numbers associated with the Cubs’ organization, whether the team goes under financially, or spends heaping sums on free agents is ultimately up to the Ricketts family. Even if the the payroll, non-payroll, and debt-related obligations exceed the team’s revenue for a few years, the Ricketts certainly have the means (and, one would hope, the wherewithal) to keep spending.

How do I put this as indelicately as possible? Even after buying the Cubs, the Ricketts family is still rolling in dough.

When the Ricketts family bought the Cubs (and Wrigley Field and a 25% stake in Comcast SportsNet Chicago), they laid out about $400 million of the approximately $900 million purchase price in cash. Where does a family, noted for owning TD Ameritrade, obtain that much cash? From selling TD Ameritrade stock, of course! And sell they did: in the first quarter of 2009, the Ricketts family sold approximately 34 million shares of TD Ameritrade stock for $11.85 a share, raising about $403 million in the process.

But, even after selling such a prodigious amount of stock, the family retained a 17.7% interest in the brokerage firm. Shares have recovered nicely since early 2009 – they now trade at a hair under $20 – and the Ricketts have about 101 million shares. That means the family’s remaining interest in TD Ameritrade alone is worth roughly $2.028 billion.

I know people gotta eat, but to suggest that the Cubs’ debt “woes” can legitimately cause the financial downfall of the franchise is to presume that the Ricketts family would let the Cubs burn while they play on their golden fiddles. And eat grapes. Peeled grapes. Grapes peeled by monkey butlers. Monkey butlers wearing diamond shoes.

In other words, I’m certainly not concerned that the Cubs will be led into financial ruin by the debt associated with the Cubs. After all, the only reason the deal was so heavily debt-financed in the first place is because doing so allowed previous owners (the Tribune Company and Sam Zell) to avoid massive tax liabilities.

As for the ability of the Cubs to add expensive free agents in 2012 and beyond, it’s much harder to say. After this exercise, I’m not as nervous as I was upon reading Wittenmyer’s piece. But then again, how much do we really know about the Ricketts’ desire to spend on the Cubs? Payroll was exceedingly high in 2010, but almost all of those obligations were in place before the Ricketts took over. In 2011, payroll fell by nearly $10 million.

We all like to talk about the $40-some million coming off the books at the end of 2011, but is it fair to assume that the Ricketts will allow whoever’s running the show to just fill that $40 million hole back up with new, expensive players, especially if it means their expenses outstrip the team’s revenues?

To be sure, we fans are not entitled to have the Ricketts spend more in 2012 than the Cubs’ revenues in 2011. After all, any reasonable business should limit its expenses to its revenues.

But, as I’ve said many times, you don’t buy a professional sports team – especially one with fans as long-suffering and blindly loyal as the Cubs – to make a buck. You buy it to show off your wealth. You buy it because you’re a fan. You don’t buy it to run it like a business. That, of course, is what made the Tribune Company such a horrible owner.

The Ricketts family can certainly afford to (a) keep the Cubs afloat for a long, long time, and (b) spend what it takes to fill holes on the team via free agency, including adding a big name or two. Whether they can do the latter without dipping into their own pockets remains to be seen. This exercise, while useful, can’t answer that question.

But, if the Cubs don’t pursue any big name free agents this offseason, at least now I’ll know at whom to be angry.

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